Where next for private markets and hedge funds in 2025? 

Private debt as an asset class has experienced strong growth since the global financial crisis (GFC), compounding a 15% annualized growth rate to approximately US$3 trillion in total assets under management (AUM) as estimated by Oliver Wyman. While leverage lending has become more crowded, we believe the asset class has room to grow and enters 2025 with a range of tailwinds, namely the continued retrenchment of bank lending, private equity dry powder at all-time highs - leading to higher demand for private debt as a financing source, and continued demand for flexible private financing solutions.

In addition, specialty finance offers a potentially rich new seam to mine. This includes financing offerings such as equipment leases, trade finance and royalty agreements, and may offer investors a greater level of diversification managed with the specialist skills required.

The opportunity set is growing, and a broader market provides tools to build custom private debt exposure according to individual risk and return profiles, which benefit investor portfolios.

Private equity (PE) was historically viewed as being synonymous with the leveraged buyout, in which an investor uses a large amount of debt to finance the acquisition of a company. Typically, the assets of the acquired company are used as collateral for the debt portion of the financing, and the company’s cash flow is expected to repay the debt over time. In this model, selling assets and cutting costs are the main levers to drive the outcome and the (private) equity investor is able to get a return without improving the underlying business. 

We agree with the many headlines expressing concern with that strategy in a high-rate environment as results are likely to be less than desired. Leverage amplifies risk, and higher rates make financial engineering difficult, but we believe there is more to the value-creation story for high-quality PE investors than leverage, and the asset class can continue to perform despite increasing interest rates, provided manager selection is strong. PE is a dynamic asset class and has performed well over time, including in periods of increasing rates.

Real assets is an investment category that entails physical ownership of real estate, infrastructure and natural resource assets. One of the more prominent unifying characteristics of real assets is that the investor has access to a dependable earning stream often correlated to broader inflationary factors, which can be particularly important to portfolios during periods of increasing prices. Real asset investments can provide inflation protection – either explicitly, through inflation-indexing mechanisms built into asset-leasing contracts, or implicitly, by being positioned to pass through rising costs once a lease expires or because inflation increases the replacement cost of the assets.

While these inflation protections can be important for a well-diversified portfolio, real assets offer investors more than just an inflation hedge. Real assets have the potential to offer a diverse category of opportunities. Investors can tailor their real assets allocations to serve one or more roles in a portfolio, including portfolio diversification or as an alpha generator to provide outperformance relative to broad markets returns.

For 2025, however, one of the most exciting areas of real assets investing, and private markets generally, lies in the areas where private equity, infrastructure and real estate overlap. Specifically, we believe there is a compelling opportunity to benefit from the rotation of infrastructure investors into more operationally oriented investments where private equity backing has been more typical at more nascent stages. As such platforms mature and are de-risked, the more natural owner is an infrastructure investor. We have been “building to core” across real estate and infrastructure since such strategies began, and believe that leaning into new areas where the same financial math can be applied is an exciting opportunity.

Some investors have a negative view of hedge funds, citing “underperformance” as the cause of that view. We contend this is a myth about hedge fund return characteristics, their roles in the portfolio and the drivers of their returns.

Hedge funds are not an asset class, they are a diverse collection of actively managed strategies across asset classes that are best utilized through a portfolio approach of multiple managers collectively trading complementary strategies. A portfolio of hedge funds has a different risk profile than that of the equity market.  

Although hedge funds can be used for a variety of purposes, we believe they best serve a portfolio as a diversifier, with the unique ability to diversify both equity market and interest rate risks. 

Hedge funds are “cash plus” investments, meaning their returns are directly related to the level of short-term interest rates. Through short interest rebates and futures collateral, several hedge fund strategies earn cash yields as a component of their returns. Now that interest rates have normalized, return expectations for hedge funds have increased materially.